The eurozone crisis – rescuing Greece
Standard Note:
SN/EP/6232
Last updated:
25 May 2012
Author:
Gavin Thompson
Section
Economic Policy and Statistics
Greece’s long-standing public debt problem became a crisis at the start of 2010 and has
since escalated to a point where it threatens the survival of the euro. In the face of rising
government borrowing costs, the country first requested international assistance on 23 April
2010. The €110bn eurozone-IMF loans agreement it received came with strict conditions on
economic policy and reform. A worsening recession and rising public opposition to further
austerity meant the Greek government struggled to meet the conditions of the agreement.
Meanwhile, the prospects of it returning to borrow on the open market by 2012, as originally
envisaged, became increasingly hopeless.
Drawn-out discussions on a second ‘bail-out’ for Greece began at an official level on 22 July
2011, and by 21 February 2012 the pieces of a more complicated arrangement had almost
fallen into place. As well as the traditional ‘loans and austerity’, the second bail-out involves
Greece’s private sector creditors taking losses on their holdings of Greek sovereign debt: this
follows from a belated recognition that no amount of austerity and loans on their own could
put Greece’s debt burden on a sustainable footing.
The second agreement avoided the imminent prospect of disorderly default only until
parliamentary elections in Greece on 6 May. The indecisive result, and the polarisation of
parties over Greece’s continued acceptance of the terms of the bail-out, meant no
government could be formed. Another election has been called for 17 June. If Greece rejects
the terms of the loans agreement, its future in the eurozone will ultimately be a political
decision on the part of the rest of the eurozone. The European Central Bank is the institution
with the power to force the withdrawal of Greece from the euro, by denying its national
central bank and financial institutions access to emergency funding.
The consequences of Greece’s departure from the eurozone are highly uncertain. Within
Greece, the extent of disruption will depend on whether it receives support from EU Member
States and institutions, in the short-run by their agreeing to capital controls, providing
technical assistance and possibly funding the recapitalisation of Greek banks, and in the
long-run by their allowing Greece to remain within the EU.
The exit of one country from the eurozone, though it would undoubtedly be characterised as
‘exceptional’ by eurozone leaders and officials, would inevitably raise questions about the
cohesion of the single currency. Even if Greece did eventually prove to be the exception, it is
argued by some that the uncertainty this would create would lead to a costly period
characterised by risk aversion, reduced confidence, depressed asset prices and economic
contraction in the wider euro area. The UK, through its trade and financial linkages with the
currency union, may see its faltering recovery stifled further, were the eurozone crisis to
continue or worsen following Greek exit from the single currency.
Contents
1 Background – the run-up to crisis
3 2 The May 2010 bail-out
3 2.1 Financing and conditions
3 2.2 Performance and outcome
4 The February 2012 bail-out
5 3.1 Loans and reform strategy
5 3.2 Private sector involvement
6 3.3 Official sector involvement
7 4 The May 2012 election
8 5 Possible outcomes from the June 2012 election
9 5.1 Pro-bailout majority
9 5.2 Anti-bailout majority
10 Leaving the euro
12 6.1 Practical issues and short-term consequences for Greece
12 6.2 Legal issues
13 6.3 Longer-term consequences for Greece
14 6.4 Wider consequences
16 Private sector losses
16 Official sector losses, including TARGET2
16 Contagion and secondary effects
17 Eurozone survival
18 3 6 6.5 Focus on the UK
18 Trade
18 Financial sector
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address the specific circumstances of any particular individual. It should not be relied upon as being up to date; the
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2
1
Background – the run-up to crisis
Greece has form when it comes to sovereign debt crises. It has spent 100 years of the past
200 in default, 1 and even when it joined the euro in 2001, its public debt exceeded 100% of
GDP, and has remained among the highest in the eurozone ever since. 2 Joining the euro, as
for other countries, allowed Greece to refinance its existing debt on more favourable terms,
and borrow more. Other factors contributing to the build-up of public debt in Greece include:•
•
•
•
•
high levels of tax evasion and weak tax administration associated with a large
informal economy
inefficient public administration
poor management of public expenditure, especially with respect to public sector wage
policy
lack of transparency in public accounting, and a fragmented budgetary process
unsustainable levels of pension spending, and weak incentives to work up to the
retirement age of 65.
Greece’s competitiveness has also been weak in relation to the eurozone ‘core’, with rising
labour costs and low productivity growth placing constraints on economic growth. 3
Despite its debt burden, and a record budget deficit in 2008, there was little evidence that
market sentiment was turning against Greece until late 2009: borrowing costs remained
within two percentage points of Germany’s, and its credit rating was downgraded just one
notch, a typical revision for the peripheral eurozone countries. The decisive moment came
after general elections in October 2009, when the new government revised the estimate of
the budget deficit for 2009 from 6.7% to 12.7% of GDP, shaking confidence in both Greek
statistics and the sustainability of its public debt.
The major ratings agencies quickly downgraded Greece’s credit rating to speculative grade,
and 10-year bond yields, a measure of the cost of government borrowing, increased from
4.9% at the start of December 2009 to 7% by the start of April. 4 Amidst rising doubt about its
ability to raise funds to pay debts falling due in May 2010, it formally requested assistance
from the IMF and eurozone on 23 April 2010.
2
The May 2010 bail-out
2.1
Financing and conditions
Following a request made by the Greek authorities for financial assistance on 23 April 2010,
an agreement was finalised on 2 May providing €110bn of loans over a three-year period. 5
Because no formal mechanisms 6 existed at this point to provide financial support, €80bn was
financed using bilateral loans from euro area member states only. These were pooled and
their disbursement managed centrally by the European Commission. The IMF provided the
remaining €30bn under its stand-by arrangement.
1
Reinhart, C. M. and Rogoff, K. S. (2008) This time is different: a panoramic view of eight centuries of financial
crisis
2
IMF World Economic Outlook database
3
See, for instance, OECD Economic Survey of Greece, 2011
4
Bloomberg
5
By the time of the second agreement, only €74bn had been disbursed; some of the outstanding balance is being
rolled-in to the second loans package.
6
I.e. the European Financial Stabilisation Mechanism (EFSM), and the European Financial Stabilisation Facility
(EFSF)
3
The release of the each of the tranches of money to Greece, Ireland and Portugal was
subject to the approval of the ‘Troika’ (the EU, ECB and IMF), following a review of their
success in meeting the conditions attached to the loan. These conditions are set out in a
Memorandum of Economic and Financial Policies, which provided an overarching strategy
for the economy over the 3-year disbursement period, and a separate Memorandum of
Understanding. The latter document detailed a highly specific programme of reform,
timetabled on a quarter-by-quarter basis. 7
The conditions attached to Greece’s first loan agreement required further austerity measures
beyond those already enacted by the government, including public sector wage and
employment cuts, reform of the state pension system, and increases in the minimum
retirement age). Beyond direct fiscal measures, more fundamental structural reforms were
also required as part of the package. This followed from the recognition that the deficit
targets required could not be achieved through tax increases and spending cuts alone. The
structural measures aimed, among other things, to tackle ‘inflexibilities’ in the labour market
to allow for greater management control over wages, working time and recruitment; to
improve tax collection; and to ‘modernise’ public administration.
There were no specific requirements in the original loan agreement for Greece to privatise
state assets. However, in return for the lower interest rates and longer repayment schedule
agreed in March 2011, the government agreed a sell-off of €50bn of public-sector assets in
April 2011, to be completed by 2015. 8
Greece's economy has contracted faster than anticipated
GDP growth - May 2010 forecasts vs Feb 2012 outturn and forecasts
2.2
4
Performance and outcome
3
The central objective of the first loans
agreement, to restore the sustainability of Greek
debt and enable it to borrow on the open
market, has clearly not been achieved.
Greece’s debt forecasts and borrowing costs
are far higher than they were in May 2010, and
by the start of 2012, a new agreement was
urgently needed to prevent Greece from
defaulting on debts falling due.
2
1
0
2010
2011
2012
2013
2014
2015
-1
-2
May 2010 forecast
-3
Feb 2012 forecast
-4
-5
-6
-7
Greece’s economic performance, too, has been
far worse than was anticipated when it first
requested assistance (see charts). Partly as a
consequence, it has struggled to implement the
reforms and meet the targets for public finances
enshrined in its loans agreement. Greece’s
difficulty in implementing austerity measures
has also been due to the problems in securing
political agreement, and, according to the
OECD, the organisation of the Greek state:- 9
And unemployment has risen faster
Unemployment rate (%) - May 2010 forecasts vs Dec 2011 outturn
and forecasts
25
20
Dec 2011
forecast
15
May 2010
forecast
10
5
The central administration lacks the
management, oversight and co-ordination
structures
to
support
effective
7
0
2010
2011
2012
2013
Greece Memorandum of Economic and Financial Policies, etc.
The deadline for completion of the privatisation programme has since been extended to 2020.
9
OECD, Greece: Review of central administration (Dec 2011)
8
4
2014
2015
implementation and long-term management of policy measures, including structural
reforms to support sustained economic growth. This is a fundamental obstacle upon
which many reforms have already stumbled.
As Greece has struggled to meet the conditions of the programme, payment of loans
instalments by the eurozone and IMF, crucial to prevent a ‘disorderly’ sovereign default, have
been delayed and conditioned on further revenue-raising and expenditure-cutting measures,
including the privatisation of an additional €50bn of state assets. As the prospects of Greece
returning to the market to borrow by 2012 became increasingly hopeless, discussions over
loans instalments under the first package also became tied-up with the negotiations over a
second loans agreement. This process culminated in the resignation of the Prime Minister
George Papandreou on 9 November, following an announcement that a referendum would
be held to secure a mandate for future reforms (the vote was never held).
3
The February 2012 bail-out
The drawn-out discussions over a second assistance package began at an official level at a
summit of eurozone leaders on 21 July 2011. 10 These continued up to February 2012, when
the prospect of Greece’s imminent default served as a spur to action. The second agreement
is more complicated than the first, and reflects the consensus that has developed since May
2010 that Greece’s debt burden as it stands is fundamentally unsustainable, and that no
amount of loans and austerity on their own will place its public finances on a sustainable
footing. Taken together, the measures in the second agreement are expected under certain
assumptions to bring Greece’s debt-to-GDP ratio down to 120.5% by 2020, close to the level
deemed sustainable by the IMF (120%). 11 The package can broken down into three parts,
discussed in turn below:3.1
Loans and reform strategy
As under the first agreement, loans are to be provided to Greece. These are necessary to
prevent a ‘disorderly default’, whereby Greece is unable to access the funds to pay off debts
falling due, most notably a €14.5bn bond redemption on 20 March. They will also ensure the
Greek government has access to finance until at least 2014. €130bn in loans is to be
provided, although the balance between the European Financial Stabilisation Facility (EFSF)
and the IMF has not yet been decided. The loans are likely to comprise €117bn in loans from
eurozone member states through the European Financial Stabilisation Facility (EFSF), and
€13bn from the IMF. €10bn in outstanding IMF contributions from the previous loans
arrangement will be added to the new arrangement, and the repayment schedule for these
extended from five to ten years. At 10%, the IMF contribution is expected to be proportionally
far lower than in previous agreements (it contributed a third of the funds to the Irish,
Portuguese and first Greek packages). The UK does not underwrite the EFSF (this is a
eurozone-only facility), but it does contribute to the IMF’s resources through its quota and
certain standing arrangements: the UK’ current share in the total (global) lending by the IMF
is around 3.2%.
In return, Greece will have to adhere to conditions relating to public spending, fiscal policy
and economic reform, and accept a high degree of oversight from ECB, European
Commission and IMF monitors; indeed, the Commission is now to have a permanent
presence in Greece specifically to monitor compliance with the programme. It will also have
to amend its constitution to prioritise debt servicing payments over other government
10
Council of the European Union, Statement by heads of state or government of the euro area and EU
institutions, 21 July 2011
11
For access to the IMF’s resources at the level Greece is requesting, the IMF requires that ‘there is a high
probability that... public debt is sustainable in the medium term’. This criterion may be relaxed if there is a ‘high
risk of systemic spillovers’. See Selected Decisions and Selected Documents of the IMF (2010), p.426
5
expenditure. Even in advance of the agreement on the package, Greece was obliged to pass
into law a €3.3bn package of public spending cuts, and the main opposition leader, Antonis
Samaras, has been required to commit to honouring the ‘objectives, targets and policies’
contained in the loans agreement Memorandum of Understanding, were he to be elected in
April.
There is likely to be considerable resistance to the reforms and austerity envisaged in the
package, and there are high levels of uncertainty both that the measures will be successfully
implemented, and that Greece’s debt burden will be returned to a sustainable level. This is
partly because the two objectives of the
package – reducing public debt as a
Under the Troika's alternative scenario, debt in 2020
proportion of GDP, and restoring
will remain well above the 120% GDP deemed
sustainable by the IMF
competitiveness
through
internal
Greece, public debt, % GDP - long-term projections
devaluation – are in basic conflict: in
simplified terms, because structural 200
no debt write-off
reforms and public spending restraint 180
alternative
impact negatively on both debt and 160
scenario
GDP, the debt-to-GDP ratio may still 140
'baseline'
remain high even as the absolute level 120
scenario
of debt declines. This ‘fundamental 100
tension’ was acknowledged by a
80
confidential debt sustainability analysis
60
prepared by the troika (also see chart),
40
which illustrated that under plausible
assumptions, Greece’s debt might not
20
be reduced below 160% GDP before
0
1990
1994
1998
2002
2006
2010
2014
2018
2020, rather than 120% envisaged
12
under the programme:The debt trajectory is extremely sensitive to program delays, suggesting that the
program could be accident prone, and calling into question sustainability
Other risks to the programme include low participation from the private sector in Greek debt
restructuring (see following section), a weaker than expected global economic environment
causing an even sharper contraction than envisaged, and difficulties in implementing the
€50bn privatisation programme. 13
3.2
Private sector involvement
The new agreement differs from all those that have gone before in that it ‘bails-in’ Greece’s
private sector creditors, albeit on a voluntary basis; that is, Greek bondholders are to be
encouraged to exchange their existing bonds for new ones with a lower nominal value. 14 The
precise terms of private sector involvement, which essentially amount to a restructuring of
Greek debt, are being drawn up by the International Institute of Finance (IIF). The main
components of the arrangement are to include:-
12
Greece: preliminary debt sustainability analysis, Feb 15 2012
The difficulties associated with the privatisation plan have been pointed out by a number of commentators; as
the FT’s Lex column put it: “In the context of the crisis Greece finds itself in... the plan borders on the
improbable. If investors are shunning Greek debt... it is hard to see why they would suddenly develop an
appetite for Greek equities”
14
A voluntary agreement is required to avoid triggering credit default swaps, financial instruments that insure
against the default and forced restructuring of debt, which could generate further financial instability.
13
6
•
•
•
A 53.5% ‘haircut’ on the nominal value of existing debt (higher than initial estimates of
up to 50%)
Of the remaining 46.5%, two-thirds will be converted into bonds of typically longer
maturity (between 11 and 30 years), and lower interest (2% to 2015, rising to 3% to
2020, and then 4.3% to 2042), partly backed by €30bn from the EFSF
The remaining third will be converted into shorter-maturity (2-year) EFSF bonds
Together, this will combine to reduce the net present value of privately held Greek debt by
around 75% 15 and, assuming full participation among Greece’s bondholders, a €100bn
reduction in debt burden.
A key concern in the PSI deal is the level of participation among Greece’s private sector
creditors. Although official sources have stated that this is likely to be ‘near universal’, other
reports have suggested that it may be as low 70-75% of Greece’s outstanding privately-held
debt, with a number of hedge funds amassing Greek debt with the intention of refusing to
participate in any restructuring agreement. The troika’s debt sustainability analysis stated
that for every 5% decline in participation, Greece’s debt-to-GDP ratio in 2020 would increase
by 2%. In order to encourage participation, Greece will ‘retrofit’ any bonds not exchanged
through the main PSI deal with collective action clauses, although this has been described as
‘not an attractive idea at all’ by the chairman of the IIF, Charles Dallara. Some commentators
predict that retrospectively changing the terms of bonds in this way could activate credit
default swaps (financial instruments that pay out in the event of a forced Greek default or
restructuring), generating financial instability.
Another reason the PSI deal is being treated with trepidation is that it could reduce the
likelihood of Greece issuing debt on the open market for the foreseeable future. This is
because the bonds being exchanged under the PSI deal are partly backed by the EFSF,
making them a far less risky prospect for investors than bonds backed by the Greek
government alone. In effect, buyers of any new Greek debt in the future would, in the event
of default, now be at the bottom of a large heap of creditors to be paid back in the event of
default, including the IMF, individual eurozone governments, the EFSF, the ECB, and PSI
participants.
By reducing the face value of their holdings, the PSI deal will affect all private sector holders
of Greek bonds, although the drawn-out nature of the crisis has meant that many financial
institutions have already made allowances for a significant write-down of Greek debt.
Financial institutions in Greece, however, which hold large quantities of Greek sovereign
debt, will face crisis without significant recapitalisation. It is reported that this will be funded
through purchase of shares by the Greek government; these are to have restricted voting
rights, thereby technically avoiding the nationalisation of major Greek financial institutions.
The troika’s debt sustainability analysis projects that €50bn will be needed to recapitalise
Greek banks to a level where they can absorb these losses.
3.3
Official sector involvement
The European Central Bank and the national central banks of the eurozone member states
are not included in the PSI deal described above. The ECB is the largest single holder of
15
The net present value is the value of the bond principal and the interest payments over time discounted back to
their present value. The net present value cut is higher than the ‘haircut’ because both the face value of the
bond and future interest payments have been reduced.
7
Greek debt (estimates put its holdings at €40bn), which it has acquired at depressed prices
as part of its Securities Markets Programme over the past year. Until recently, it had been
fiercely resistant to having its holding of Greek debt restructured, arguing the debt had been
acquired for monetary policy purposes, and that allowing its face value to be reduced would
violate the principle of ‘no monetary financing’ of eurozone governments.
The difficulty with this position, as pointed out by the head of the IMF, Christine Lagarde, lay
in the fact that unless such official holdings of Greek debt were restructured,
commensurately larger ‘haircuts’ would be required of the private creditors, which reduced
the likelihood of achieving an agreement with widespread participation. 16 Other
commentators also pointed out that there was no legal reason why ECB holdings of Greek
bonds should have any special status imparted to them, and that it stood to profit from its
Greek debt holdings, since they were acquired at below their face value. 17
Under the programme, the ECB has agreed to distribute profits from its holdings of Greek
government bonds to the eurozone’s national central banks; these proceeds will then help to
fund a lowering of the interest rates on all official loans to Greece (i.e. under the first and
second programmes), so that the margin on these is 150 basis points (1.5%) above the
market cost of financing the loans, as opposed to 200 basis points (2%) previously. In
exchange, the ECB has been allowed to swap its existing Greek bonds for new contracts that
will ensure it cannot be compelled to participate alongside private sector creditors in future
restructurings. Profits from any holdings of Greek government debt held by national central
banks are to be distributed directly to Greece.
4
The May 2012 election
The legislative elections in
Distribution of votes - Greek legislative election, May 2012
Greece on 6 May 2012 left its
parliament
divided
evenly
between groups of parties that
New Democracy - 18.9%
support the loans agreement
Syriza - 16.8%
and those that oppose it. In
Pasok - 13.2%
Independent Greeks - 10.6%
particular, the Syriza party,
KKE (Communist) - 8.5%
Golden Dawn - 7.0%
(also known as the Coalition of
Dimar - 6.1%
the Radical Left), which placed
Others - 19.0%
second in the elections, are
strongly opposed to the
Distribution of seats - Greek legislative election, May 2012
agreement, describing the
attached
conditions
as
‘barbaric’. The party refused
New Democracy - 36.0%
to engage in negotiations
Syriza - 17.3%
Pasok - 13.7%
with the ‘pro-bailout’ Pasok
Independent Greeks - 11.0%
and
New
Democracy
KKE (Communist) - 8.7%
Golden Dawn - 7.0%
parties, despite the Pasok
Dimar - 6.3%
leader and former Deputy
Prime Minister Evagelos
Venizelos proposing a ‘progressive disengagement’ from the loan conditions. Dimar (also
known as the Democratic Left) was unwilling to enter into a coalition without the participation
16
17
See, for instance Lagarde presses ECB over debt deal, 24 Jan 2012
See, for instance, the FT Alphaville blog Dealing with Greece’s biggest holdout, 13 Jan 2012
8
of Syriza, leaving the parties irreconcilably polarised and unable to form a majority
government. 18 A new vote has been called for 17 June.
The indecisive result in Greece, and the strong vote for parties opposed to the terms of the
bailout, have once again called into question the country’s future in the euro, and the
sustainability of externally-imposed measures that, at least in the short-term, are so
economically damaging and lacking in public support. The results left senior eurozone
leaders in a bind, since they firstly had to be seen to respect the election results; secondly to
be seen to believe in the cohesiveness of the currency union; and thirdly to take a nonnegotiable stance on the bailout conditions. The response has been to play on Greeks’
desire, evident from opinion polls, to remain in the euro. Just as the aborted referendum on
the terms of a second loans agreement in November 2011 was characterised as a vote on
eurozone membership (see Section 2.2), so too has the June 2012 election been recast as a
referendum on Greece’s future in the single currency:We have to respect that there will be new elections in Greece... we will make it clear
that we want Greece to remain in the eurozone, and that is what the citizens are voting
on. [Angela Merkel, following first meeting with Francois Hollande, 15 May 2012] 19
We want Greece to remain part of our family, of the European Union, and of the euro...
this being said, the ultimate resolve to stay in the euro area must come from Greece
itself [European Commission president Jose-Manuel Barroso, 17 May 2012] 20
Although this approach has been described as an ‘agreed position’ of the EU institutions and
eurozone leaders, there are some indications of discord. EU Trade Commissioner Karel De
Gucht said on 18 May that the Commission and ECB were ‘working on emergency scenarios
if Greece does not make it’; but the Economic and Financial Affairs Commissioner Olli Rehn
denied this. The President of the Eurogroup, Jean-Claude Juncker came out fighting in a
press conference on 14 May, describing talk of Greek exit from the euro as ‘nonsense [and]
propoganda... we have to respect the Greek democracy’, but was reported as warning the
Greek finance minister at the meeting that same day that the 17 June elections were
Greece’s ‘last chance’ to stay in the eurozone, and that were a secret vote to be held among
eurozone leaders on Greece’s membership, ‘an overwhelming majority [would be] against’.
5
Possible outcomes from the June 2012 election
5.1
Pro-bailout majority
If a majority coalition of ‘pro-bailout’ parties can be formed after the 17 June elections, a
disorderly default and the possible exit of Greece from the euro area may be averted, at least
in the short term. However, the country has already experienced an exceptionally severe
recession and cuts in public sector spending (see table below), and if its economy does not
quickly see a return to growth and a revival in employment under the new programme, the
same pressures could re-emerge. If this happens, the question of Greece’s exit from the
single currency will be firmly back on the table.
18
Of the remaining parties, KKE (Communist) is opposed to the bailout, along with Independent Greeks
(moderate right) and Golden Dawn (extreme right).
19
Quoted in Merkel and Hollande spell out Greek fear, 15 May 2012
20
Quoted in Greeks urged to run poll as vote on euro, 17 May 2012
9
Greece's recession and austerity have been severe by eurozone and international standards
Selected indicators, peripheral eurozone and other economies experiencing financial and sovereign debt crises
Greece
GDP fall, peak to trougha
Peak unemployment
a
Private consumption, peak to trough
Real disposable income, peak to trough
a
Government expenditure, peak to trough
a
Ireland Portugal
Spain
Italy
Latvia, Argentina,
2007
2002
Mexico, Indonesia,
1994
1998
-16%
21%
-12%
15%
-5%
14%
-4%
23%
-5%
9%
-24%
17%
-20%
24%
-8%
8%
-13%
6%
-15%
-23%
-14%
-9%
-6%
-8%
-6%
-4%
-2%
-6%
-27%
-24%
-25%
-24%
-9%
-5%
-4%
-18%
-34%
-14%
-7%
-4%
-2%
-18%
-7%
-9%
-25%
Fall from peak to Q4-2011 for eurozone countries
Sources: Reuters; IMF World Economic Outlook database
Indeed, even the IMF itself has suggested that the terms of the bail-out may be too harsh,
and that the pace of fiscal consolidation could be slowed. The fifth review of Greece’s
performance under its loans agreement, in March 2012, stated:- 21
Staff argued that demand effects from the implementation of structural reforms, as well
as weaker economic prospects in Europe, called for a longer adjustment period (thus
also allowing a more accommodative fiscal policy in the near term). The authorities
argued that prolonging the adjustment path beyond 2014 would pose risks to
credibility, and given resistance from their European partners, worried that this would
be seen as a lack of commitment to Stability and Growth Pact targets.
In this context, it seems that a renegotiation of the bailout may well occur even if Greece
elects a government that supports the conditions as they stand.
5.2
Anti-bailout majority
Conversely, if Syriza win the June 2012 elections, an a majority ‘anti-bailout’ coalition may be
formed. 22 Ultimately, Greece’s future in the euro if it rejects the terms of its current loans
agreement will be a political and economic, rather than a legal one. On the one hand, EU
Member States may ‘blink’ and agree to relax the terms of the agreement in a way that is
acceptable to the Syriza party; on the other, they may refuse and stop disbursements of
loans under the existing arrangement. With Greece unable to service its debts, it would
default in a ‘disorderly’ way at some point before the end of June. 23
Even if this political trigger were activated and Greece defaults, it does not necessarily follow
that the country needs to leave the euro. The probable death-knell would be the refusal of
the European Central Bank (ECB) to accept Greek sovereign debt as collateral against
lending to Greek banks. Shut out of interbank lending markets, banks in Greece have
become heavily reliant on emergency lending from both the ECB and Greece’s national
central bank. This lending is secured against their holdings of Greek sovereign debt and
other collateral. The ECB has repeatedly lowered the standards of collateral it accepts in its
emergency lending operations to accommodate Greek banks; the Greek national central
bank, meanwhile, accepts even lower-quality collateral. Outright default on Greek sovereign
debt would be a very good reason for the ECB to reject this collateral once and for all. With a
two-thirds majority, the ECB can also stop any increase in the Greek national central bank’s
21
IMF Greece: request for extended arrangement under the extended fund facility – staff report, p.19 (March
2012)
22
The winner of the largest number of votes gets a 50-seat ‘bonus’ in the Greek parliament, making the fact of
victory as important as the margin.
23
Reuters Greece might run out of cash by end June if no government – sources, 7 May 2012
10
lending to Greek banks. This would effectively ‘pull the plug’ on the Greek financial system.
Were the ECB to call in the €140bn debts already extended to Greek banks, this could
happen in dramatic fashion, since every domestic bank in Greece would be rendered
immediately insolvent. 24
Options for Greece
Greece elects/forms a
govt that refuses
current bailout
conditions
Greece elects/forms
a govt that accepts
bailout conditions
No renegotiation;
Greek govt loses
access to funding;
disorderly default
Bailout terms
renegotiated in a
mutually acceptable
way
ECB refuses Greek
sovereign debt as
collateral, and stops
national central bank
lending
ECB continues
existing policy
towards Greek banks
Euro exit averted
(for now)
Capital flight; financial
collapse; euro exit likely
Mutually acceptable
insolvency plan
negotiated
There are other options for the ECB, however. If it is willing to bend its collateral rules still
further, or continue to allow the Greek national central bank to lend to the financial sector,
then Greece can be kept in the euro area. Again, the ECB’s decision will be a political one.
As a recent Goldman Sachs report noted:- 25
In the end, the ECB is unlikely to accept final political responsibility for excluding
Greece from the Euro area and/or precipitating a Greek financial collapse. It will
therefore have to make decisions across these dimensions in conjunction with the
governments of core Euro area countries, who would then decide Greece’s fate in that
regard.
Even if the ECB were to continue to support Greece following default, a plan to deal with
sovereign insolvency would quickly have to be negotiated and agreed. Some commentators
have suggested a ‘Marshall Plan’ for Greece, involving debt relief and fiscal transfers from
the eurozone ‘core’, although there has been considerable resistance in countries such as
Germany to provide the eurozone periphery with loans, let alone grants. 26
24
See, for instance, Paul Mason for BBC Watch deposit flight, not the eurocrats, 16 May 2012
Quoted on zerohedge blog What happens if Greek payments stop: Goldman’s thought experiment on ‘the day
after’.
26
See, for instance, JP Morgan Greek contagion, reproduced on zerohedge blog, 14 May 2012
25
11
6
Leaving the euro
Greece’s exit from the euro would occur at the point where the ECB refuses to lend to Greek
banks and stops Greece’s national central bank from doing the same. 27 Without the support
of the ECB, Greece’s relationship with the euro would be similar to that of Montenegro’s,
which uses the currency without being part of the currency union and (hence) without access
to ECB support. Such a situation might be induced by the interaction of market forces and
politics: for instance, a deadlock between the Greek government and EU Member States and
institutions could cause a run on Greek banks and the need for a sharp increase in
emergency central bank funding. Were the ECB to refuse this, (i.e. deny the Greek central
bank the ability to create euro-denominated loans), the pressure to prevent a collapse of the
Greek financial system by imposing capital controls and redenominating to a new currency,
would be overwhelming.
If it seems unlikely that other eurozone members would wish to Greece stay in the euro
having again repudiated the terms of its loans agreements, it is worth bearing in mind the
costs attached to Greek exit from the euro not just for Greece itself, but for the euro area and
the wider EU. This is discussed in Section 6.4.
6.1
Practical issues and short-term consequences for Greece
For a peripheral country like Greece, there are two stages to leaving the euro. The first would
be redenomination, a technical exercise whereby all prices, payments, bank deposits and
those debts issued under Greek law are converted into the new currency (call it the new
drachma) through an act of parliament. Taken with devaluation (see next paragraph), this
would result in them losing their value (in euro terms). Those contracts issued under foreign
law could also be redenominated, but creditors would have recourse to courts outside
Greece to secure repayment in euro.
The second stage would be devaluation (a loss in the value of the new drachma, relative to
the euro and other countries), which would be an inevitable economic consequence of
leaving the euro for a country like Greece. This is partly because the country has weak
competitiveness, and there would be an excess of supply over demand for its the drachma at
the starting rate; and partly because the widespread expectation of devaluation would
precipitate just that outcome (a self-fulfilling prophecy), as individuals exchanged drachmas
for euros ‘today’ in anticipation that the rate at which they can do so ‘tomorrow’ will be lower.
Based on the experiences of Latin American countries in the late 1990s and early 2000s,
some commentators have suggested that a new Greek currency would lose 30-60% of its
value. 28
The effect of redenomination and devaluation would be to lower the purchasing power of
Greek wages and savings, but also to reduce the value (in euro terms) of debts and other
obligations. In advance of any departure from the euro, there would thus be a strong
incentive for savings held within Greece to be moved abroad (a process known as capital
flight), or simply held as cash, to spare them from redenomination. The effects of this could
be severe, with runs on banks creating the possibility of financial collapse, especially if the
Greek central bank was prohibited from providing lender of last resort protection to financial
institutions. As Willem Buiter notes, ‘the Greek banking system would collapse even before
27
The ‘formal’ exit of Greece for the eurozone would be a far more drawn-out process, involving changes to the
EU Treaties (see Section 6.2)
28
See, for instance, Buiter and Rahbari Rising risks of Greek euro area exit, 6 Feb 2012
12
Greece had left the monetary union’. 29 To an extent, capital flight has already been occurring
for two years, and accelerated following the election results on 6 May (the term ‘bank jog’
has been used by some commentators to describe the recent outflow of deposits). 30
To mitigate these effects, careful planning would be necessary in the run-up to euro exit. An
element of secrecy could be maintained in the early stages, but most commentators believe
that the process of printing a new currency could not be done in secrecy. Capital controls
that prevent cross-border movements of money, combined with bank holidays to prevent
withdrawal of deposits, could buy time to allow the redenomination of debts and savings to
take place; both of these measures would have to be imposed without warning if they were to
be effective.
In terms of printing and distributing new notes and coins, Capital Economics estimates the
lead time for this process at anything from a few weeks to six months. It is clearly not
possible for banks to be shut for this long. The solution they propose in their Wolfson Prize
submission is to accept that there will be a period without new notes and coins, and to rely
on non-cash payment mechanisms (electronic, cheque and informal) for the majority of
transactions. Euros could continue to be used (at least for a transition period), though euro
withdrawals from banks would need to be treated as a foreign currency transaction, debited
from drachma-denominated accounts at the prevailing exchange rate.
Clearly the extent of disruption to Greece caused by euro exit will depend to a great extent
on the level of co-operation and support provided by EU Member States and institutions, in
the short-run by agreeing to capital controls, 31 providing technical assistance and possibly
funding the recapitalisation of Greek banks, and in the long-run by allowing Greece to remain
within the EU.
6.2
Legal issues
There are no provisions in EU law that allow a country to withdraw from the euro. The Lisbon
Treaty did, however, include an article that allowed for the withdrawal of a member state from
the EU itself:- 32
Any Member State may decide to withdraw from the Union in accordance with its own
constitutional requirements.
The exit clause further provides that a Member State wishing to withdraw from the EU must
inform the European Council of its intention; the Council is to produce guidelines on the basis
of which a withdrawal agreement is to be negotiated with that Member State; and the
Council, acting by a qualified majority and after obtaining the consent of the European
Parliament, will conclude the agreement on behalf of the EU. The withdrawing Member State
would cease to be bound by the treaties either from the date provided for in the withdrawal
agreement or, failing that, two years after notification of its intention to withdraw. 33 Having
withdrawn from the EU, the former Member State would then be at liberty to choose their
currency. Of course, a country wishing to leave without going through these formalities could
29
Buiter and Rahbari, Citi Global Economics View, 13 Sep 2011
See, for instance, FT Brussels Blog The slow-motion run on Greece’s banks, 17 May 2012
31
These contravene EU Treaties, but can be imposed for up to six months if approved by the Commission, the
ECB and a qualified majority of Member States
32
A more thorough analysis of the legal issues surrounding leaving the EU can be found in Library Standard Note
SN/IA/6089 In brief: leaving the European Union
33
ECB Withdrawal and expulsion from the EU and EMU – some reflections, Legal working paper series 10/2009
30
13
simply walk away from its treaty obligations, though it could be fined at the Court of Justice
for doing so. 34
There is, however, no mechanism by which a country could leave the euro while remaining a
part of the EU, and the weight of legal opinion, including that of the ECB, is that withdrawal
from the euro without simultaneous EU membership withdrawal would be illegal under the
current Treaty provisions, and in defiance of the ‘irreversibility’ of monetary union. For a
country to remain an EU member having withdrawn from the euro would thus require a
negotiated agreement with other Member States. Such an agreement would necessarily
involve a Treaty amendment and the unanimous consent of Member States.
Some commentators have suggested that a possible Treaty change that would allow Greece
to remain in the EU having left the euro would be the insertion of a monetary union ‘opt-out’
along the same lines that enjoyed by the UK and Denmark. 35
6.3
Longer-term consequences for Greece
Positive consequences – the case for euro exit
The question of whether exit from the euro would be ‘desirable’ for certain countries,
especially Greece, is hotly debated. On the one hand, some commentators point out that
currency devaluation is exactly what many struggling peripheral countries need to restore
their export competitiveness (through the effect on relative prices of exports and imports),
and reduce relative wages and unit labour costs. A new, relatively cheaper, currency would
also make the country more attractive as a destination for both doing business and taking
holidays. Leaving the euro and letting the currency fall, therefore, offers an alternative to the
harsh process of fiscal austerity and ‘internal devaluation’ (the process of allowing priceadjusted wages to fall) currently being imposed on the eurozone periphery, a process which,
it is asserted, is doomed to failure:Cutting public deficits will reduce demand both at home and in other euro-zone
members. As several, if not all, members of the euro-zone are attempting to improve
their position through cutbacks, they will find that they are pedalling ever harder to
remain in more or less the same place. Even if the consequent downward pressure on
wages and prices results in an improvement in competitiveness, for most countries this
will take many years, if not decades, to work.
Moreover, price deflation would worsen the financial problem because it would
increase the real value of debt, thereby intensifying both the downward pressure on
aggregate demand and the fragility of the banking system. (This is the phenomenon of
debt deflation, as explained by Irving Fisher.) So the objective of improving
competitiveness is at odds with the objective of reducing the debt burden. [Capital
Economics, Wolfson Prize submission, p.7-8]
Combined with devaluation, redenomination could also achieve a major reduction the
effective public debt burden in euro terms, and it would be possible to reduce the real value
of the debt in ‘drachma’ terms by engineering or tolerating a higher rate of inflation
(something not currently possible with the ECB in control of monetary policy). Though there
will be little scope for boosting demand through fiscal measures, the flexibility to undertake
alternative monetary policy, such as quantitative easing, may enable governments to
stimulate domestic consumption. Finally, regaining control over currency issuance would
34
35
Ashurst London Exiting the euro – legal consequences, Jan 2012
Capital Economics Leaving the euro: a practical guide, see in particular p.26-7
14
enable the exiting country to finance its debts (or at least credibly commit to doing so)
through printing money; it may therefore enable the Greek government, over the longer term,
to borrow money on the open market once again.
Negative consequences – the case against euro exit
On the other hand, it is asserted by some that the benefits of exchange rate devaluation in
the eurozone periphery are exaggerated. In Greece, for instance, Willem Buiter points out
that, with only two large labour unions, there are currently no significant co-ordination
problems that might prevent downward adjustment of wages, and therefore the benefits of
adjustment through the alternative mechanism of devaluation are minimal:- 36
It is our view that, without simultaneous deep structural changes in the legal... and
regulatory determinants of the balance of bargaining power in labour and product
markets, without the removal of barriers to entry in the private service sectors and
without the privatisation of a vast array of inefficient state-owned enterprises, a sharp
depreciation/devaluation of the New Drachma would go through the nominal wage and
other nominal domestic cost structure like a dose of salts. Following a sharp bout of
inflation, the same uncompetitive real equilibrium would be restored.
At least initially, even if the country did not default in a technical sense, the effective default
on liabilities arising from redenomination would mean the government and private sector
would be cut off from external funding (i.e. they would be unable to borrow on the open
market). In assessing the benefits of euro exit with respect to debt and borrowing conditions,
the crucial questions are then how soon they would regain access to external funding, and at
what interest rate. Greece is heavily reliant on external funding to finance its current account
deficit, and a prolonged period shut out of debt markets would, according to Buiter, ‘force a
savage compression of imports and a deep recession’. 37
It is also pointed out that euro exit cannot simultaneously address the problem of poor
competitiveness and excessive debt. As Capital Economics points out:- 38
A successful devaluation which left a lasting impact on competitiveness would depend
upon any inflationary upsurge being kept in check. So even if inflation were a viable
and successful way out of the debt problems (which is itself debatable) the need to
improve competitiveness rules it out. This means that excessive debt will need to be
addressed by other means, probably involving some measure of default.
A devaluation might also eliminate the economic imperative to enact the structural and fiscal
changes many see as necessary to repair the Greek economy; namely, reforming labour
markets, raising the retirement age, and reducing the generosity of pensions.
36
Buiter and Rahbari, Citi Global Economics View, 13 Sep 2011
Buiter and Rahbari Rising risks of Greek euro area exit, 6 Feb 2012
38
Capital Economics Leaving the euro: a practical guide, p.12
37
15
6.4
Wider consequences
Private sector losses
Exposure to Greek debt, by location
Selected economies, by sector, Dec-2011, $bn
To the extent that foreign banks are
France
exposed to (i.e. held) the private, banking
Germany
and public debt of Greece, they could
experience losses on its exit from the
UK
eurozone, whether or not the currency in
Public
US
which the debt was payable was
Non-bank private sector
Banking
changed. 39 The chart on the right shows
Switzerland
the exposure of Greece’s public and
Italy
private sector creditors by location:
Belgium
France and Germany hold the majority of
Greek debt. UK financial institutions hold
Spain
around $8.3bn of Greek non-bank private
0
10
20
30
40
50
debt, $3.3bn of public debt, and $1.1bn of
Source: Bank of International Settlements,
banking debt. 40 Foreign banks have
Quarterly Review, Appendix Table 9E
reduced their exposure to Greek debt by over
60% since 2009.
60
Official sector losses, including TARGET2
To varying and complex degrees, official institutions in the eurozone are exposed to Greek
debt. Eurozone states are exposed through loans provided directly and via the EFSF under
the Greek bail-out agreements (around €53bn in bilateral loans and a further €73bn through
bank recapitalisation and guarantees for private bondholders agreed as part of the second
bail-out). They are further exposed through the ECB and national central bank holdings of
Greek debt: the ECB also holds around €40bn of Greek debt, although this has been
exempted from any future restructurings, meaning it will get paid back ahead of ordinary
creditors in the event of default. The IMF has disbursed around €23bn in loans to Greece, of
which the eurozone is liable for around €4.4bn (and the UK €1bn), although in the event of
default the IMF gets paid back before all other creditors.
One of the most significant liabilities to eurozone countries arises through the mechanism
that processes cross-border bank transfers in the eurozone, known as TARGET2. Following
the creation of the eurozone, financial institutions retained their accounts at their respective
national central banks. Through these accounts, cross-border payments are credited and
debited. As this occurs, the national central banks mediating the transaction accumulate
credits and liabilities to the TARGET2 payment mechanism. For instance, a cross-border
payment of €1,000 from Greece to Germany leads to a claim by German central bank on the
TARGET2 mechanism of €1,000, and a liability by the Greek central bank for the same
amount. Greece’s liability to the TARGET2 system has accumulated rapidly in recent years,
partly as a result of its weak competitiveness and trade deficit (more is paid for imports than
is received in return for exports), partly because investors have scaled back their holdings of
Greek debt, and more recently as savings in Greek banks are moved abroad. So long as the
euro area is cohesive, there is no risk of loss through TARGET2; but where a country with
liabilities to TARGET2 reverts to its own currency, it may repudiate the claims of other central
39
If redenomination of debts into the new currency did not occur, the burden of repayment would increase as the
new currency depreciated in value, making default more likely. If redenomination did occur, this would be
tantamount to default since the value of payments in the new, depreciated currency would be lower than if
they were in euro.
40
Bank of International Settlements, Quarterly Review, Appendix Table 9E
16
banks. Formally, these losses would be shared out among the remaining eurozone countries
in proportion to their capital share in the ECB (based on population and economic size);
however, in the event of the collapse of the eurozone, this formula might not be relevant. 41
Official sector exposure to Greece
Belgium
Germany
Ireland
Spain
France
Italy
Cyprus
Luxembourg
Malta
Netherlands
Austria
Portugal
Slovenia
Slovakia
Finland
Estonia
Euro area
Memo: UK
Bilateral loans
EFSF
ECB Target2
ECB/EIB holdings
of Greek debt
IMF
Total
% GDP
1.9
15.2
0.3
6.6
11.4
10
0.1
0.1
0.1
3.2
1.6
1.1
0.2
0
1
0
52.9
2.7
21.2
0
9.3
15.9
14
0.2
0.2
0.1
4.5
2.2
0
0.4
0.8
1.4
0.2
72.9
4.6
36.2
2.1
15.9
27.2
23.9
0.3
0.3
0.1
7.6
3.7
3.3
0.6
1.3
2.4
0.3
130
1.5
12
0.7
5.3
9
7.9
0.1
0.1
0
2.5
1.2
1.1
0.2
0.4
0.8
0.1
43
0.3
1.1
0.1
0.4
0.8
0.6
0
0.1
0
0.4
0.2
0.1
0
0
0.1
0
4.4
11.0
85.7
3.2
37.5
64.3
56.4
0.7
0.8
0.3
18.2
8.9
5.6
1.4
2.5
5.7
0.6
303.2
2.9%
3.3%
2.0%
3.4%
3.1%
3.5%
3.3%
1.8%
4.3%
2.9%
2.9%
3.3%
3.9%
3.7%
2.9%
4.2%
3.2%
0
0
0
a
1.0
1.1
0.06%
0.1
a
The UK is exposed via the EIB's holdings of Greek sovereign debt, which are said to be between €100m and €1bn. Based on a 16.2% shareholding, this
gives the UK an exposure of between €16.2m and €162m.
Source: Nomura Economics; IMF finances data; Bloomberg; ONS National Accounts
Contagion and secondary effects
The idea of a country leaving the euro was until recently a political taboo. This is because
investors’ perceptions of the riskiness attached to the debt of particular eurozone countries is
to an extent dependent on their belief in the commitment of leaders to do whatever is
necessary to maintain the currency union in its present form. By admitting that they were
willing to conscience euro exit for Greece (which they began to do from November 2011), 42
eurozone leaders were implicitly admitting they are willing to conscience it for others, too.
Similarly, the exit of one country from the eurozone, though it would undoubtedly be
characterised as ‘exceptional’ by eurozone leaders and officials, would inevitably raise
questions about the cohesion of the single currency. Even if Greece did eventually prove to
be the exception, it is argued that the uncertainty this would create would lead to a costly
period characterised by risk aversion, reduced confidence and depressed asset prices.
Higher risk premiums for the debt of other peripheral eurozone countries would increase the
likelihood of sovereign debt crises, while capital flight and risk aversion among banks would
raise the chances of financial crises. Economic activity would also be depressed by a dryingup of credit to businesses, and by the effects of weak consumer and business confidence on
investment and consumption.
41
See, for instance, Martin Wolf What has the ECB done in the crisis? The role of TARGET balances, FT 28 Dec
2011. For more on the TARGET2 system and the accumulation of claims on the eurozone periphery through
this mechanism, see Sinn and Wollmershaeuser (2011) Target loans, current account balances and capital
flows: the ECB’s rescue facility
42
Following the Greek Prime Minister’s announcement of a referendum on the terms of a second loans
agreement, Angela Merkel stated at a press conference on 3 November 2011, “the referendum will revolve
around nothing less than the question ‘does Greece want to stay in the euro: yes or no?’”
17
Eurozone survival
Greece’s exit from the euro is unlikely to cause the break-up of the currency union on its
own: its economy is small, and its interconnectedness with the rest of the eurozone, via the
financial sector and trade, is comparatively limited. In isolation, the wider losses from Greek
exit would, in the view of many, be sustainable. The real danger of Greek exit arises from the
contagion to larger and more integrated economies discussed above. Whether this happens
will depend on the extent to which investors see Greece as a special case, and hence on
whether a convincing posture of solidarity and commitment to the currency union can be
sustained following Greece’s departure.
6.5
Focus on the UK
Despite the focus on the problems of the eurozone, the UK’s economy has not outperformed
the currency union as a whole over the past two years, and its output remains further below
the pre-recession peak. The Government has distanced itself politically from the eurozone
through its refusal to sign the ‘fiscal compact’ Treaty. However, the UK and the eurozone
economies for the time being will remain closely intertwined: strong links through trade and
the financial sector mean that, were the eurozone crisis to continue or worsen following
Greek exit from the single currency, it could further stifle the UK’s faltering recovery. As
Mervyn King put it:- 43
The euro area is tearing itself apart without any obvious solution. The idea that we
could reasonably hope to sail serenely through this with growth close to the long-run
average and inflation at 2% strikes me as wholly unrealistic
As in the rest of Europe, the effects of Greek exit on the UK are highly dependent on the
extent of contagion, described in Section 6.4 above. In isolation, even a severe economic
crisis in Greece would not be disastrous because the UK’s trade links with Greece are
minimal, and its exposure to Greek debt is relatively low and declining. The secondary
effects of Greek exit, however, in the form of a collapse in confidence and a more general
downturn in the euro area, are potentially more severe and highly uncertain.
Trade
In 2010, Greece was the 32nd most important destination for UK goods (£1.4 billion or 0.5%
of all UK goods exports) and the 29th most important destination for UK services (£1.1 billion
or 0.7% of all UK services exports). It is thus not a significant export market. More details are
available in the Library Standard Note UK-Greece Trade Statistics.
More generally, 47% of total UK exports went to the eurozone in 2011. Exports to the
eurozone have held up despite the crisis (see chart), largely because most go not to the
beleaguered periphery, but to Germany, France and the Netherlands, which have performed
far more strongly. Most forecasters expect trade to be the strongest driver of GDP growth in
the UK in 2012, and so adverse developments there have the potential to return the UK to
recession, particularly if the effects are felt in the eurozone ‘core’ that comprise the UK’s key
export markets. Demand for UK exports might also be affected were the euro to fall
significantly against sterling, as might happen were the economic situation to deteriorate.
43
Press conference on Bank of England Quarterly Inflation Report, quoted in BBC Bank governor warns of euro
crisis ‘storm’, 16 May 2012
18
Financial sector
The UK financial sector was exposed to
around $12bn of Greek debt at the end of
2011. In the event of euro exit, there is a
high risk of heavy losses on this debt, both
directly through default, and indirectly
through the redenomination of contracts
into a new currency (which would rapidly
devalue). In isolation, the effects on the
UK financial sector from Greek exit are
widely considered to be manageable. 44
Linkages through third countries may,
however, generate more substantial
losses: UK financial institutions are more
heavily exposed to French banks, which in
turn have much greater exposure to
Greece (around $56bn at the end of
2011).
Source: Bank of England statistical database, Series VPQB2S3GR;
VPQB2S4GR; VPQB2S5GR
Significant writedowns on their holdings Note: due to differences in methodology, figures may not precisely
European debt would raise concerns about UK match the chart showing international comparisons of exposure in
Section 6.4
banks’ profitability. This, combined with more
general stress in financial markets that might follow from Greek exit, could raise UK banks’
borrowing costs and limit their capacity to lend to the domestic economy, something which
could hinder economic recovery. More seriously still, in the event of larger economies such
as Spain and Italy being forced out of the euro, or full eurozone break-up, the financial
linkages between the eurozone and the UK would, in the view of many, precipitate a banking
crisis in the UK and the requirement for urgent recapitalisation, possibly using public funds.
44
See, for instance, UK fears sound of a Greek exit, FT 18 May 2012
19